Australia | Jul 04 2007
By Chris Shaw
In a continuation of what has been a tough year or so for the company, Sigma Pharmaceuticals (SIP) has revised down its earnings guidance for both this year and FY08. It now expects EBITDA (earnings before interest, tax, depreciation and amortisation) in FY07 to increase by 5% against 10% previously while FY08 results should be flat against the market’s previous expectations of a 10-15% increase.
The changes in earnings represent margins and profit being squeezed both by an increase in competition in the generics sector as well as an unlikely resolution of CSO (community Service Obligation) payments.
The revised guidance from management has been followed by brokers cutting their earnings forecasts as the profit shortfall won’t be offset by the announcement of a share buyback, some also downgrading their rating on the stock to reflect dissatisfaction with the company’s performance.
Credit Suisse is one to make such a move, downgrading the shares to Neutral from Outperform on the view the market will now place less confidence in the abilities of the management team as a result of earnings being lower than expected.
JP Morgan also sees the credibility of the management team as coming into question following the update, the broker adding it still sees potential for earnings in FY08 to come in below the revised guidance. While it sees some value in the stock at current levels, this possible downside risk means it remains too early to turn positive in its view.
Merrill Lynch also rates the stock as Neutral for similar reasons, the broker pointing out the current competitive pricing in the generics sector that is bringing down margins is unlikely to go away anytime soon, so it too doesn’t believe the current price weakness is an opportunity for investors.
One who does is Citi, the broker retaining its Buy rating while pointing out the stock is now a high risk rather than a medium risk play. For the broker the main issue is industry rationalization, which it sees as inevitable given there are simply too many warehouses and trucks and too much inventory moving around in the Australian generics market.
Given it is the major player the broker sees Sigma as the most likely to be able to bring about effective changes to the industry structure, though here to date it has been hindered by adverse rulings by the ACCC. Nevertheless, the broker expects eventually there will be a shakeout and the company should benefit.
The margin issue is unlikely to be favourably resolved anytime soon in the broker’s view as Ranbaxy has been aggressively discounting prices for two major generic drugs in an attempt to lift market share, a move to date that has achieved nothing but to bring down generic prices generally and increase the level of competition.
It suggests the buyback announced by the company is evidence the share price is undervalued, not least because as the best-placed in the industry either the company should be able to make money or the whole sector is at risk of disappearing.
Sharing the Citi view is UBS, which sees the stock as oversold at current levels even when allowing for the pressure on generic drug prices. Deutsche disagrees though, suggesting the FY08 guidance requires a recovery in performance in the second half of the year, which may not occur given the ongoing pricing pressure. With risk remaining squarely to the downside the broker has joined the list of those downgrading their rating, moving to Hold from Buy.
The lower earnings guidance in combination with a clouded industry outlook has taken its toll, the FNArena database showing the stock is now rated as Buy twice and Hold eight times, compared to six Buys and four Holds prior to the update in guidance. The average price target according to the database is $2.19, down from $2.76.
Shares in Sigma are slightly stronger in today’s trading and at 11.55am were up 0.5c at $1.75.